PE pays price for collusion

In a large-scale case of corporate back scratching, some of the world’s biggest private equity investment firms are accused of colluding to keep the cost of takeover deals down, writes Jordan Bintcliffe


“Henry Kravis just called to say congratulations and that they were standing down”, wrote Hamilton James, President of Blackstone – a rival private equity company to Kohlberg Kravis Roberts (KKR). “[Kravis] had told me before they would not jump a signed deal of ours.”

James later sent an email to Kravis’ cousin and co-founder of KKR, George Roberts, writing: ‘We would much rather work with you guys than against you. Together we can be unstoppable but in opposition we can cost each other a lot of money.’

‘Agreed,’ replied Roberts.

That email exchange was in 2006, in the midst of the $17.6bn deal for US semiconductor maker Freescale, which KKR decided to step away from. Freescale was eventually acquired by a consortium led by Blackstone, which included Carlyle, TPG, and Permira.

This complicity apparently went on for a number of years, and affected the outcome of deals worth billions of US dollars. One of these was the $32.1bn buyout of hospital chain HCA by a consortium involving Blackstone and KKR. This buyout was, at the time, the biggest LBO ever (it’s now ranked third largest), according to data compiled by Bloomberg. KKR allegedly asked its partners in the scheme to step down on its takeover.

Blackstone then brought back firms that had ‘lost’ in the bidding, and gave them financial roles in the deal, saying: “you scratch our back, we scratch yours.” A recently revealed 220-page antitrust lawsuit, Dahl versus Bain Capital Partners, alleges that those deals were just a small amount where some of the world’s largest private equity investment firms were colluding to stifle competition. Doing so held down the prices of takeover targets by millions of US dollars in some of the biggest deals of the boom.

Targeting accusations
The private equity industry has previously been secretive about its internal operations, wanting to keep the lawsuit out of the public eye. But its October 2012 unsealing by a federal judge in Boston helped shine a light on the surprisingly congenial relationships between the firms accused in the allegations, going after some of the largest names in the industry, including Blackstone, KKR, Bain Capital, TPG, and the Carlyle Group. It targets nine private equity firms in total, as well as Goldman Sachs and JPMorgan Chase.

The case has been brought by a large combined group of pension funds, including the Police and Fire Retirement System of the City of Detroit, and a Minnesota-based investor, Kirk Dahl, who owned shares of Freescale. The plaintiffs were shareholders of the companies purchased by the private equity firms between 2003 and 2007, and claim they lost money from the deals because of the co-operation between the companies involved.

Having further investigated the deals, the plaintiffs updated the complaint with emails referring to deals inked by each firm accused of forming ‘clubs’. The supposedly offending deals were made between 2003 and 2007, at the LBO market’s peak. President of Blackstone, Tony James, commented on the filing, saying: “The lawsuit is a complete fabrication and a bunch of malarkey.”

“When it comes to big deals, it’s not only perfectly permissible for our firms to team up, but it’s a requirement,” said James, “And when you’re in any competitive situation, you want to pick the strongest partner you can.”

But the lawsuit claims that the wording used in the companies’ emails, such as ‘club etiquette’, ‘quid-pro-quo’, ‘payback’, and ‘professional courtesy’ are more than the normally polite but competitive rhetoric of deal making, and instead float somewhere in the realm

of ‘anti-competitive conduct.’ Furthermore, the suit alleges that ‘inferior sham bids’ were knowingly made by the accused businesses.

This quid-pro-quo culture that existed was highlighted in an email sent to Blackstone’s James by Silver Lake Partners co-founder Glen Hutchins, who was apparently anticipating a favour in return for the $11.4bn Sungard deal: “We invited you into Sungard and have a reasonable expectation of your reciprocating,” wrote Hutchins, according to the complaint.

Another example is the takeover of the Kinder Morgan energy company for $26.5bn by a group that included Goldman Sachs and Carlyle. At the time, Carlyle co-founder David Rubenstein wrote in an email to the founder of Carlyle’s European arm that they were joining the deal, “because we had complained about Goldman competing with us and never having brought us a deal. So [former Goldman Sachs Chairman Henry] Paulson told his partners to bring us into the deal.”

The details of 27 deals are included in the lawsuit, up from nine originally. The judge allowed the expansion of the investigation due to the uncovering of further evidence relating to the deals in the case.

If it were found that the firms had agreed not to compete with each other, then the reduced prices they paid for the takeover targets would have impacted the amount of money that shareholders received. The filing states: “The measure of harm the shareholders suffered is the difference between the price the shareholders received for their shares and the price they would have received ‘but for’ defendants’ conspiracy,” “Recent economic scholarship and analyses confirm that shareholders received far lower prices in LBOs than they would have in a competitive market during the Conspiratorial Era.” The US Department of Justice has been investigating the issue with a probe that dates back to 2006. It may be telling that they have so far remained silent on the issue – the case may not be strong enough for action against the industry.

Risk-led payout
Legal experts have said that companies working together to spread risks out is acceptable behaviour when taking on a big investment, and that much of the alleged wrongdoing is not conspiracy, but rather companies working together to spread the risks of huge investments. But if the accused firms are found guilty, the affected shareholders may see a huge pay out; in some antitrust cases, plaintiffs have received three times the damages they suffered.

KKR’s spokeswoman Kristi Huller responded to the allegations, saying: “they make the preposterous claim that the entire private equity industry came together under a master plan to decide which firms would be permitted to acquire any particular public company. There is no evidence of such an arrangement, and the facts in the case show exactly the opposite: private-equity firms spending millions of US dollars pursuing companies that they never acquired, repeatedly increasing the prices they offered and paying substantial premiums to shareholders through multiple rounds of hotly contested bidding.”

Owen Blicksilver, a spokesman for TPG, a company also involved, said: “TPG never colluded to suppress deal prices. We competed vigorously for deals that the firm both won and lost. In instances where we considered, but did not move forward with a competing bid, it was a decision based on whether the pursuit and ownership of the asset would be in the best interest of our limited partners. The plaintiffs have no basis to suggest otherwise, and we intend to continue to vigorously defend against their claims.”